Last week, news broke that Bayer (OTCPK:BAYZF) (OTCPK:BAYRY) had agreed to acquire Monsanto (NYSE:MON) in a deal valued at $128 per share, a hefty premium over where shares of the business were trading before rumors began circulating earlier this year about a potential acquisition and 25.7% above where shares of Monsanto are trading for as of the time of this writing. In this piece, I want to explore one method investors should consider if they want more bang for their buck, a method that could allow them to more than triple their money.
This article is not meant to re-hash my most recent piece on the acquisition, which covers not only some of the history of the process explored by both firms but also covers what I believe the market's perception of the deal is right now. Before any investors decide to buy or sell shares of either of these players, I would recommend that you revisit that article so that you understand what Mr. Market seems to be thinking right now and can understand and appreciate the regulatory issues facing the acquisition in the months to come.
Show me the money!
When investing in the market, investors have a simple goal of maximizing their returns on a risk-adjusted basis. Mergers and acquisitions can often skew these returns because, if Company A is definitely going to acquire Company B (or is even very likely to) then the returns by going long Company B and perhaps even shorting Company A (depending on the circumstances) could present investors with attractive upside but with little risk.
However, there is one big flaw for this kind of activity. In many circumstances, mergers and acquisitions can also be very binary in nature. Either you get that attractive return relative to the risk or, if the deal falls through, your downside can be very meaningful since the acquiree's shares should fall, potentially even to the price shares were trading at before a deal was announced. In my last article on this acquisition, I showed that Mr. Market thinks a transaction may very well not happen between the companies due to regulatory concerns, but I also said that if the deal doesn't go through then the $2 billion breakup fee paid by Bayer to Monsanto could soften the blow for investors in Monsanto and mitigate downside.
Having said all of this, for investors who believe very strongly that a deal between these two players is likely to succeed, as Bayer's management team has indicated, there is one approach that could more than double an investor's money should they turn out to be correct. These details can be seen in the table below.
*Table Created by Author Using Google Finance Data
According to management at Monsanto, the transaction should be completed, barring regulatory issues, sometime by the end of 2017. As of the time of this writing, the furthest into the future that investors can buy or sell options of Monsanto for would be January of 2018. These are in the $105, $110, $115, $120 and $125 increments for prices below the $128 purchase price for the firm.
As you can see by looking at the table, the difference between the $128 buyout price agreed upon by both players and the strike prices plus the current cost of the 2018 call options ranges anywhere from a high of $9.40 per share to a low of $1.15 per share. In a world where investors buy into these call options and hold them until maturity, only exercising them at that time and assuming that the deal does go through, the amount of profit generated shows that investors would get anywhere from 2.45 times their money back to 3.14 times their money back.
Based on these numbers, investors who strongly believe that Monsanto will be acquired by Bayer for the price agreed upon could be in for a nice payday if they end up buying January 2018 call options on Monsanto. There are, however, some risks involved with this transaction. Should the deal fall through, for instance, it is possible that, unlike just buying shares of Monsanto, investors could lose most, if not all, of the money put into this strategy.
Since call options (all options really) expire worthless if they are not exercised, shares of Monsanto taking a dive (or even just not rising enough on their own fundamentals) should a deal not be consummated, could leave no value for investors or very little if they sell the options before expiration. Another material risk is if a deal is still up in the air due to regulators (and still perceived as unlikely by market participants) and ultimately gets pushed back into 2018. Even if a transaction does go through, if the confirmation that it will does not satisfy the market before expiration then investors could still lose out on all or most of their money.
As of this moment, it seems as though the upside potential for investors looking to buy into Monsanto's shares and/or its call options could be material. This is great for investors who turn out to be correct but in the case of the options strategy, investors should be especially aware of the risks they face. Should something happen that destroys the transaction (which would most likely be something that is regulatory in nature), a potentially large payday could turn into a costly loss, but for some investors this upside may outweigh the downside.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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